A federal judge accused prosecutors Thursday of overreaching in their attempt to show that former KPMG executives sold questionable tax shelters to wealthy clients.
Lawyers involved in the case expect U.S. District Judge Lewis Kaplan to reject defendants' calls to dismiss the case.
The New York judge, however, faulted what he called the government's "shameful" activity that led the accounting firm not to pay defendants' legal bills, contrary to past practice. He also suggested that prosecutors drop some lesser counts.
The government is accusing 18 defendants, including 16 former KPMG executives, of scheming to defraud the Internal Revenue Service by setting up bogus tax shelters, which created at least $11.2 billion of fake tax losses for hundreds of wealthy clients.
KPMG agreed last August to pay $456 million, accept an outside monitor and admit to wrongdoing in resolving a federal probe into the shelters.
Stanley Arkin, a lawyer for former partner Jeffrey Eischeid, accused prosecutors of using KPMG's deferred prosecution agreement as a sword to stop defendants from arguing that they believed in good faith that the shelters were "more likely than not" lawful.
Though Kaplan questioned some of Arkin's arguments, he reserved stronger criticism for lead prosecutor Justin Weddle.
Some defendants argued in court papers that prosecutors pressured KPMG "not to pay legal fees for any partners indicted on criminal charges, even if they had 'cooperated' with the government."
Weddle argued that KPMG's admission of wrongdoing warranted charges against individual defendants.
But Kaplan said the government, through its communications, was "depriving people ... potentially ... of counsel."
It is unknown when Kaplan will rule on how the case should proceed. Trial is set to begin in September.
Separately, three former KPMG auditors settled regulatory charges over their roles in the 2002 audit of Tenet Healthcare Corp., agreeing to suspensions of their licenses to sign off on audits of public companies.
The three were accused by the Securities and Exchange Commission of failing to conduct a proper audit, including inappropriately modifying working papers.